This is by far my most favorite trading tool and I am pleased to share it with you. It provides empirical proof that profitable trading is not solely dependent on a high winning percentage. This tool is one of the features included with the desktop software that comes with my swing trading course. Try it out, I am sure you will agree it is an eye opener.

How to use this tool.
1. Enter the values for Win/Loss ratio and Win Probability (3.0 would be a 3 to 1 win/loss ratio and .50 would be a 50% win probability)
2. Enter desired “Lines Qty” to draw multiple equity curves3. Click the “Generate” button to generate simulated equity curves

Frequently Asked QuestionsWhat does this tool show?This tool simulates an equity curve of your account over the long term after systematically applying known parameters of Win Probability and Win/Loss ratio of trading results. Each equity curve consists of about 385 trades which is a statistically significant sample. The random generator decides (as the market does) with a given probability whether you win or lose in a given trade. The equity curve trajectory is then generated. 100 is the starting point so any lines above that are profitable.

What is a “Win/Loss ratio” parameter?
Divide your average winner by your average loser and you get Win/Loss ratio

What is a “Win Prob” parameter?
This is the number representing probability of a winning trade of your trading system. For example, if you traded 100 times and won in 61 trades, then the probability to win is about 61% or 0.61.

What is a “Lines Qty” parameter?
This is abbreviation for “Lines quantity”. This is the number of equity curves to be generated and plotted simultaneously. This feature gives you an opportunity to see “what if” scenarios for any ‘level of luck’. In other words, even your system wins in 99.9% of times, there’s non-zero chance that all your trades can lose for example 10 times in a raw.

What are the “Kelly Val” and “Math Expect”parameters?
Kelly Value and Mathematical Expectation of the trading system respectively. The first one determines the percentage of your capital you should put in a single trade in order to maximize the over-all account performance in a long run and minimize the risks of ruin. The second one is interpreted this way : if it is positive than historically your system wins on average, if it is negative then you better look for another strategy.

The Kelly Criterion arose from the work of John Kelly at AT&T’s Bell Labs in 1956. His original formulas dealt with long-distance telephone transmission signal noise. But the gambling community quickly understood that the same approach may help them to calculate the optimal amount to bet on a horse and the best way to take advantage of overlays and underlays, maximizing the growth of your bankroll over the long term. Nowadays, Kelly Criterion is a recognized money management system and whenever the question of optimal betting size pops up in handicapping or money management books you always see Kelly formula mentioned.

The Kelly’s formula is : Kelly % = W – (1-W)/R

where:

* Kelly% = percentage of capital to be put into a single trade
* W = Historical winning percentage of a trading system
* R = Historical Average Win/Loss ratio

The math behind the system is pretty complicated. Kelly’s original paper is all but unreadable to non math majors.

For more in-depth information about using Kelly’s value in stock trading and long term investing please read the following literature (free ebooks):

On the roulette wheel there are 36 numbers, double zero, and the blank. That makes 38 spaces to bet on. Each bet costs $1 to play. The winner pays $35. To calculate the mathematical expectation of the roulette wheel you do the following:

Multiply the probability of winning by what you win when you win. And from that, you subtract the probability of losing by the cost of each bet. The difference is the mathematical expectation. If it’s positive, it’s a fair bet. If it’s negative, you don’t play.